January 24, 2008

Trade and the great divergence

Opening up to international trade raises the return to skills in advanced economies and reduces it in the less advanced ones, according to the standard factor-endowments story. If human capital accumulation in turn depends on these returns to skills, trade should enhance human capital accumulation in the rich countries, but slow it down in poor economies. In other words, trade could serve to accentuate over time an initial divergence in income levels. As a result of trade, already rich countries should end up growing faster, while poor countries remain poor.

Just a theoretical possibility? In an interesting paper, Oded Galor and Andrew Mountford argue that it is a lot more than that. This story may help account for the "Great Divergence" in economic history--i.e., why Britain took off while India, say, failed to industrialize (yes, yes, I know there are other reasons too...). It may also shed light on the failure of poor countries to converge to the living standards of the rich in the current era of globalization.

It's not that there are no gains from trade for both sides. But rich countries take the gains in the form of larger income per capita, while the poor take it in the form of larger population (higher fertility).

Aside from an interesting historical discussion, Galor and Mountford provide some striking evidence on the contemporary relationship between trade, on the one hand, and fertility and education, on the other. Controlling for endogeneity and other possible problems, they show that larger trade shares are associated with lower fertility and greater investment in education in the OECD economies, but with higher fertility and lower education in developing economies.

I am more convinced by the historical discussion than by the contemporary evidence (for one thing, the skill premium has generally risen--not fallen--in most developing economies opening up to trade in recent decades). But I do find these scatter plots intriguing.

Comments

I had thought that one of the arguments was that population growth (in the form of increased lifespan) supported human capital accumulation, as persons made rational decisions to invest in themselves. One would have to look at both changes in population and changes in lifespan, I think.

I think this could maybe be part of the explanation of the widening wealth gap in South Africa, where the average white person still earns 8 times a black person (according to a recent study by the Institute for Justice and Reconciliation (IJR)). An analysis of the flow of young (white) South Africans to other countries to gain job experience and advanced training shows that when these people eventually return to South Africa, they generally find employment at a much higher salary level than their counterparts that remained in the country. They also come back wealthier after saving money while working abroad.

This is evident in my neighborhood (that is mixed race upper middle class) where most of the white people are working in international firms, or travelling abroad frequently, while most of the black people are working in government.

People that are connected or exposed to international business practice appears to be much wealthier and higher paid than people that only interact locally. Furthermore ,all the internationally connected people appear to be more mobile, and can switch to any international job very fast. While most of the people that are focused on the domestic market seem to be more dependant on things here working out

How does this dovetail with the massive salary increases in percentage terms amongst the educated in India since circa 2000? Or soaring wages for every skill class in coastal China since circa 1978?

Perhaps the problem is with the misnomer "developing country". Countries that don't have the basics of "peace, easy taxes, and a tolerable administration of justice" may well indeed be caught in a Malthusian trap where greater national income gets translated into high population but not per capita GDP.

But the poor countries that have their stuff together to a high enough degree (usually bit by bit over time) all seem to have rising per capita GDP. Think Botswana, Chile, Estonia, Hong Kong etc.

In other words, build it and they will come, with "it" being good enough institutions, and "they" being actual development on a per capita basis.

By the way, I am suspicious of screening out other plausible positive growth variables. I think there is a multiplier effect where different positive variables act more in a geometric manner than an arithmetic one, with the sum in effect being greater than the parts.

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Perhaps there are two currents at work today. Opening up of markets shifts production of skill-intensive goods to the more developed countries. At the same time, the less developed countries grow --which also increases demand for skill intensive goods in those countries, some of which is provided domestically.

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I am suspicious of screening out other plausible positive growth variables. I think there is a multiplier effect where different positive variables act more in a geometric manner than an arithmetic one, with the sum in effect being greater than the parts.

Thanks Dani - nice blog. I agree with one of the earlier comments that stated: "People that are connected or exposed to international business practice appears to be much wealthier and higher paid than people that only interact locally"

People that are connected or exposed to international business practice appears to be much wealthier and higher paid than people that only interact locally. Furthermore ,all the internationally connected people appear to be more mobile, and can switch to any international job very fast. While most of the people that are focused on the domestic market seem to be more dependant on things here working out

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It has been said that world population and a prime cause of the 'Great Divergence' in income per capita across countries in the last two centuries. The analysis suggests that international trade had an asymmetrical effect on the evolution of industrial and non-industrial economies. While in the industrial nations the gains from trade were directed primarily towards investment in education and growth in output per capita, a significant portion of the gains from trade in non-industrial nations was channelled towards population growth.

Trade and commerce are inter linked.These are somethings that are needed for the fast economic growth of the country.I agree with the statement of the author.The author must have studied a lot in this respect.

Perhaps the problem is with the misnomer "developing country". Countries that don't have the basics of "peace, easy taxes, and a tolerable administration of justice" may well indeed be caught in a Malthusian trap where greater national income gets translated into high population but not per capita GDP.

It has been said of which planet population and a perfect source of the particular 'Great Divergence' within income per capita over nations inside the latter hundreds of years. The actual research indicates that overseas industry acquired a great irregular in shape effect on the actual advancement of industrial and non-industrial economic climates. Whilst in the business nations around the world size increases coming from business were directed mainly toward expenditure within education and learning and also expansion in output per person, a substantial part of size increases coming from deal inside non-industrial countries ended up being fed toward populace expansion.

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International trade has its pros and cons. The main one is, as you mentioned, more divergence of income levels globally, with basically rich countries developing more and poor countries remaining poor.

Yes, poor countries benefit too...but the problem is that a slight rise in income is closely correlated to increases in population due to high birth rates, and high population means that the per capita income basically remains low.